Fighting back from a sharp sell-off earlier in the session, stocks finished modestly higher last Friday, though the broad market still posted its fourth consecutive week of losses. Initially following through on bearish momentum from the previous day's plunge, the major indices trended lower throughout most of the day, but swiftly reversed higher in the final two hours of trading. The benchmark S&P 500, down 1.7% at its mid-day low, managed to close 0.3% higher. Although the Dow Jones Industrial Average eked out a gain of just 0.1%, the Nasdaq Composite turned its 1.1% intraday loss into a 0.7% advance. The small-cap Russell 2000 and S&P Midcap 400 indices rose 0.5% and 0.2% respectively. Each of the main stock market indexes finished near its best level of the day.

Total volume in the NYSE increased 5%, while volume in the Nasdaq was on par with the previous day's level. Since stocks finished in positive territory and near their intraday highs, the flat to slightly higher volume was positive. Turnover in the NYSE was the most active day of 2010. In the NYSE, advancing volume only marginally exceeded declining volume. However, the adv/dec volume ratio in the Nasdaq was positive by a ratio of 5 to 2. Considering how negative market internals were earlier in the session, the final adv/dec numbers were solid.

The bullish reversal that capped the final hours of last week's session had the feeling of a short covering rally. The fact that Mondays have generally been positive days for the market, combined with the market's short-term oversold condition, provided the perfect excuse for the bears to cover their short positions ahead of the weekend. Nevertheless, the two-hour rally showed a decent amount of power, and also caused the major indices to form bullish "hammer" candlestick patterns on their daily charts. Below, this is shown on the daily chart of the Dow Jones DIAMONDS (DIA), a popular ETF proxy for the Dow Jones Industrial Average:



When the "hammer' pattern forms after an extended downtrend, it is a bullish indicator that tells us prices moved sharply lower at some point during the day, but the buyers firmly regained control into the close. Often, this pattern leads to higher prices in the near-term, and there is a good chance stocks may now pop higher for a few days. However, one must be prepared for the possibility that institutions are merely waiting to dump more shares into the strength of any decent bounce. A ton of overhead supply has been left in the wake of the market's recent correction, and the technical damage of this correction has been more significant than other recent pullbacks. With confirmed "lower highs" and "lower lows" on most of the charts, it seems unlikely stocks will quickly zip back to new 52-week highs this time, as they have done during other pullbacks of the past year. Nevertheless, the near-term sentiment could easily turn bullish, enabling the main stock market indexes to rally back up to their 20 and/or 50-day moving averages.

If traders desire to enter new long positions because of last Friday's reversal, it may be a relatively safe bet if taking a near-term view, and if willing to quickly pull the plug if the rally attempt stalls. But with nearly every ETF showing a technically damaged chart, what should one buy? In this case, the broad-based ETFs may be the best play, as they're assured of going up if there is to be an overall bounce in the stock market. Taking it a step further, one would buy the broad-based ETF that sustained the least damage during the recent correction, as there will be less overhead supply to contend with. In comparing the daily and hourly chart patterns of the S&P 500 SPDR (SPY), Dow Jones DIAMONDS (DIA), Nasdaq 100 Tracking Stock (QQQQ), S&P Midcap SPDR (MDY), and iShares Russell 2000 (IWM), the S&P Midcap SPDR may be the best-looking of the bunch.

The most significant difference between MDY and the rest of the broad-based ETFs is where its current price lies in relation to prior levels of support. Specifically, MDY is the only one still trading above its late-November 2009 lows, and it's not even too far away from rallying back above the highs of its prior consolidation from October and November. Furthermore, the 20-day exponential moving average only started to cross down through its 50-day moving average last Friday. With the rest of the major indices, that happened around one week ago (compare the MDY chart to DIA above). When market sentiment changes, the crossover of the 20-MA through the 50-MA is a confirming signal of a trend reversal. In this case, a confirmed crossover would be more negative than a trend in which the moving averages have not yet crossed over, or have not really confirmed such action. This is shown on the daily chart of MDY below:



Honorable mention goes to QQQQ, which has also been holding up better than SPY and DIA throughout the broad market correction, is still (barely) holding above its late November lows, and also showed the most relative strength last Friday. However, MDY seems to have a slightly better edge. As such, we plan to enter a small position of MDY today, as a momentum trade, but with a very short timeframe in mind. Regular subscribers should note our specific trigger, stop, and target prices for the MDY trade setup below.

Open ETF positions:

Long - UUP
Short (including inversely correlated "short ETFs") - SRS

Deron Wagner is the Founder and Head Trader of both Morpheus Capital LP, a U.S. hedge fund, and MorpheusTrading.com, a trader education firm.